Cliff Taylor: Interest rates are likely to go a lot higher than we had expected

The focus of this week’s cost-of-living package was, understandably, all about energy and prices in the shops. But in terms of the impact on the economy, something else is coming sharply into focus – interest rates. It was notable that Sinn Féin’s reaction to the Government package this week majored on the troubled outlook for renters and for mortgage holders. There is little political mileage in opposing the giving away of money. But rising interest rates are going to become a significant economic issue this year and a really big political one.

We know interest rates are rising. But what has changed is the likely extent of the increase. The European Central Bank (ECB) deposit rate is now at 2.5 per cent – and up to recently the expectation had been that it would top out around 3 per cent, or slightly higher. Now, financial markets expect that this rate could rise to 3.75 per cent. The change is based on two things. One is the regular drumbeat of increasingly hawkish warnings from senior ECB figures. The second is that the euro zone economy looks likely to skirt recession, and stronger growth means more upward pressure on inflation.

The ECB is trying to slow the euro zone economy, setting it up for conflict with governments as the year goes on. It seems determined not to waste a good crisis and to get interest rates back to more “normal” levels. To paraphrase, the interest rate beating will continue until the economic mood worsens. We are in the strange world where good news – of a euro zone economy avoiding recession – is bad news in terms of what mortgage holders might be faced with.

More increases are now a nailed-on certainty. The ECB will increase interest rates by another half a point in the middle of next month and there will be a strong lobby on its governing council to do the same at the subsequent meeting in early May. Another smaller rise over the summer could bring deposit rates to 3.75 per cent.

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This would mean that the other key ECB rate – the refinancing rate – off which tracker mortgages are priced could reach 4.25 per cent, pushing the average tracker rate to not far off 5.5 per cent. That would be a rise of more than four percentage points since last summer, before the increases started. For someone with €150,000 outstanding on a tracker mortgage that would equate to around €280-€290 extra per month, or more than €3,400 per year. And some of those whose loans were sold to vulture funds, and are already facing their rate rising to 8 per cent, could see it reach 9.25 per cent over the summer.

The combined impact of the cost-of-living crisis and higher mortgage rates could, the Central Bank has calculated, increase the number of households under real financial pressure from 9 per cent to 12 to 13 per cent

It will also mean a fundamental change to the new loans market. Borrowers could have got a new loan – to buy or move – at around 2 per cent, or slight higher, last summer. If the increases so far are fully passed on by lenders, the best new rate would rise to 5 per cent. These means repayments on a €300,000, 30-year loan would increase from around €1,100 per month to around €1,600, according to calculations by Darragh Cassidy of Bonkers.ie. If new loan rates went to 6 per cent, this rises to around €1,800. These higher rates will also kick in for people who bought homes in recent years on low rates and locked in for 3 to 5 years, but will have to face the music when the fixed term ends.

There are economic and political implications of all this. Households are far less exposed than they were before the financial crash, though Central Bank research highlights potential difficulties for a smaller group of lower income households with relatively high borrowings. The combined impact of the cost-of-living crisis and higher mortgage rates could, it has calculated, increase the number of households under real financial pressure from 9 per cent to 12 to 13 per cent. However, many more will feel the pinch and have to cut back in other areas.

House prices

Higher interest rates will slow the economy – that is what the ECB wants to happen, after all. And they are bound to have an impact on house prices. Most market analysts still predict some increase in prices this year, though Cassidy believes falling prices look likely. Another possibility is outlined in relation to the UK housing market by a report this week from the Joseph Rowntree Foundation, which said that falling affordability combined with a resilient jobs market could leave the market in a kind of stagnation, with prices stuck, a sharply falling level of transactions and many potential buyers effectively locked out. In this context, it is worth watching the level of housing sales in the Irish market early this year to see if similar trends are evident here.

Politically, rising mortgage rates are going to be big. Sinn Féin has already mounted a campaign for the return of mortgage interest relief on a temporary basis; the problem is that this ends up helping a lot of people who didn’t need it, and also that mortgage relief, once reintroduced, would be very difficult to abolish. Just look at the 9 per cent rate for hospitality, the VAT with nine lives.

[ Irish mortgage rates remain among lowest in Europe but set to climb fast, says Central Bank ]

The Government has its exposures. It was Michael McGrath, now finance minister, after all, who in opposition was calling for the Central Bank to be able to cap interest rates in certain circumstances. The Central Bank doesn’t want to go near this.

And this Government and the last one repeatedly reassured those whose mortgages were sold to vulture funds that they would retain all the protections of those with bank loans. All the protections, it turned out, except when interest rates started to rise and the already high interest rates they are being charged shoot even higher. Initial Central Bank estimate are that around 38,000 borrowers are particularly exposed, facing high rates and not able to switch to fixed-rate products. Nobody, of course, foresaw interest rates rising so quickly. But they have done – and there is more to come.